Accounting for
Bad Debts
Created 2009
By Michael Worthington
Elizabeth City State University
Objectives
Define uncollectible accounts and writing-off bad debts Prepare journal entries for the Direct Method Discuss the contra account for Accounts Receivable Explain the matching conceptContrast Direct __________ with the Allowance Method
Prepare journal entries for the Allowance Method using a percentage of sales estimation
Prepare journal entries for the Allowance Method using percentage of Accounts Receivable estimation
Doubtful Accounts
When a customer does not pay their bill when it is due, it is said to be an doubtful _________ (bad debt or uncollectible account)
Firms have policies that determine when an account is considered doubtful; for example, if account is 90 days past due
But companies continue collection efforts even when the account is seriously past due
Write-Offs
Unfortunately firms cannot collect all invoices, so they must write-off some __________ (remove from their books)
An event triggers the write-off, perhaps a bankruptcy or failure of an agency to collect
Even so, firms never lose hope that they can collect at least some of their money eventually
Direct Write-Off Method
Direct Write-off Method records expense when a specific customer’s __________ is uncollectible
Debit Credit Bad Debt Expense XXX
Accounts Receivable - J.Doe XXX Firms must use Direct Write-Off Method for income tax returns, even if Allowance Method is used for their financial statements
Allowance for Uncollectible Accounts
Allowance for Doubtful Accounts appears in the assets section of the __________ Sheet
Allowance account REDUCES the net amount of Accounts Receivable, so it is known as a contra account (“contra” means opposite)
ASSETS SECTION OF BALANCE SHEET Accounts Receivable $ 210,000 Less Allowance for Doubtful Accounts $ 40,000 Net Accounts Receivable $ 170,000
Allowance for Doubtful Accounts has a credit normal balance, even though assets generally have a debit normal balance
Matching Concept
Match Expenses to Revenues
Record ALL expenses in the same period as the related revenue is recorded
So companies must accrue (record) the estimated amount of bad debt ___________ in the same period as the sales
Firms use various names for bad debts such as Uncollectible Accounts, Doubtful Accounts or Reserve instead of Allowance
Direct Method Allowance Method
No journal entry required Prepare journal entry to debit estimated amount of Bad Debt Expense and credit Allowance for DA
Debit Bad Debt Expense and credit Accounts Receivable
Credit Accounts _____________ and debit Allowance for Doubtful Accounts
Only one journal entry Two journal entries
At end of period when sales occurred
When specific customer’s account proves to be uncollectible
Percentage of Sales
Bad debts may be estimated as % of credit sales Percentage is based on past __________ and judgment
For example, if bad debts averaged 4% of sales over last five years but the economy was beginning a recession, management might estimate that 5% of current credit sales will result in future bad debts Example: Acme Inc. had credit sales of $500,000 and estimated that 5% will result in bad debts ($500,000 x 5% = $25,000)
Debit Credit Bad Debt Expense $25,000
% of Accounts Receivable
Bad debts may be estimated as a __________ of Accounts Receivable Percentage is based on past history and judgment
For example, if bad debts averaged 2% of AR over last five years but the economy was beginning a recession, management might estimate that 3% of current AR will result in future bad debts
Example: Acme Inc. had Accounts Receivable of $40,000 and estimated that 3% will result in bad debts ($40,000 x 3% = $1,200)
Adjust Allowance for Doubtful Accounts
The percentage of Accounts Receivable (AR) method requires adjustment of the balance of the Allowance for Doubtful Accounts If the estimated bad debts = $1,200 and balance of Allowance for Doubtful Accounts was $1,000 credit
The balance of the Allowance for Doubtful Accounts should be increased by $200 ($1,200 - $1,000)
Debit Credit Bad Debt __________ $200
Allowance for Doubtful Accts $200
Debit Balance
If the balance in Allowance for Doubtful Accounts has a credit balance, subtract the ____________ from the computed amount
However, if the balance in Allowance for Doubtful Accounts has a DEBIT balance, ADD the balance in the account to the computed amount
Debit Credit Bad Debt Expense $2,200
Allowance for Doubtful Accts $2,200
If the estimated bad debts = $1,200 and balance of Allowance for Doubtful Accounts was $1,000 DEBIT
The balance of the Allowance for Doubtful Accounts should be increased by $2,200 ($1,200 + $1,000)
Collecting Written-Off Account
Even if a firm has written-off an account, they still hope to collect at least some of their ___________Debit Credit Accounts Receivable $1,200
Allowance for Doubtful Accts $1,200
Cash $1,200
Accounts Receivable $1,200
If a customer had filed bankruptcy, eventually the trustee will pay creditors a percentage of the debt
Reverse the write-off adjustment for the amount collected, and then
debit Cash and credit Acct Receivable
Example: wrote off balance of $2,400, but then collected one-half of the debt from bankruptcy court
SUMMARY
Direct Write-Off Method – When a specific customers’ account is determined to be uncollectible, debit Bad __________ Expense and credit Accounts Receivable
Allowance Method – Estimate doubtful accounts, debit Bad Debt Exp and credit Allowance for Doubtful Accts
Then write-off specific customer’s account by debiting Allowance for Doubtful Accts and crediting Acct Rec
Percentage of Sales Allowance Method – estimate the amount by multiplying credit sales by the percentage
Percentage of AR Method – estimate the amount by multiplying balance of AR by the percentage, then add to a debit balance in the Allowance Account, or subtract a credit balance from the computed amount
